Obama Administration Pushing for Regulatory Reform on Many Fronts
Wednesday, September 23, 2009
The battle to pass regulatory reform legislation in the face of intense opposition launches in earnest Wednesday morning with a hearing featuring Treasury Secretary Timothy F. Geithner, who will once again champion a package of sweeping changes that only Congress has the power to make.
But outside that spotlight, the Obama administration, and the independent agencies with which it is increasingly synchronized, are moving forward with changes that do not require new laws, but could match or exceed the impact of anything that emerges from Capitol Hill.
The Federal Reserve is cracking down on Wall Street's legendary paydays. The Treasury Department plans to require banks to carry larger capital reserves. The Securities and Exchange Commission has eight pending proposals to clean up financial markets.
Even the Supreme Court has jumped in, surprising experts with a June ruling that gave states more room to pursue banks for violations of lending laws.
The administration's decision to pursue reform on multiple fronts reflects its judgment that many things need to be fixed, and its desire to make changes before the adrenaline of the crisis is replaced with the lethargy of renewed prosperity.
The risk, however, is that the administration is stretched too thin, unable to resolve challenges that complicate nearly every piece of the reform agenda, including its centerpiece legislative proposals for a new agency to protect consumers and a new authority to regulate large financial firms.
This week, Geithner is making multiple trips to Capitol Hill even as he prepares for weekend meetings in Pittsburgh with his counterparts from the G-20 nations, where he will pursue an international consensus to increase capital requirements.
Capital is a reserve against unexpected losses raised from sources that do not need to be repaid, such as money from the sale of common stock. During the boom, financial firms were allowed to place larger investment bets without holding more capital. As losses rose, investors concluded that firms lacked sufficient reserves, and a panic ensued. A wide range of experts now regard forcing banks to hold more capital as perhaps the single most important reform to financial regulation.
"It's enormously important because capital is the most fundamental measure of a bank's financial health," said Richard Carnell, a law professor at Fordham University who served as an assistant Treasury secretary in the Clinton administration. "This is the most serious and costly regulatory failure in the history of the world and that needs to be front and center."
The Treasury said earlier this month that firms should hold more capital based on four key characteristics: a company's size, its funding sources, the nature of its investments, and connections with other firms. The intent is to reward firms that become smaller, more stable and less likely to require a federal bailout.
But Carnell and other experts caution that the Treasury's proposal remains vague, and they said it is not yet clear whether the administration intends to push for an increase in capital standards that they would regard as sufficient to safeguard institutions.
"You can put a big brake on size in the financial system if you want to," said Simon Johnson, an economist at the Massachusetts Institute of Technology who writes a weekly online column for The Washington Post. "But it's not clear to me that they're going to do it."
The Federal Reserve, meanwhile, is asserting authority to review bank compensation policies. There is widespread agreement that many bankers were paid during the boom for spectacular short-term results achieved by taking massive risks that ultimately produced the global crisis.
The Fed is expected in the next few weeks to release for public comment a proposal instructing banks to make sure that compensation reflects risk. For example, if two employees generate the same amount of profits while taking different amounts of risk, regulators would like to see more reward for the less risky approach.
The Fed would focus on about two dozen of the largest banks, which would be required to submit detailed compensation schemes so that regulators could compare practices among companies, with an eye toward discouraging outsized rewards.
The SEC also is flexing its muscles. The commission has proposed restrictions on short selling and a ban on a type of electronic trading, called flash orders, that critics say gives some powerful financial players an unfair advantage. It plans more aggressive oversight of money market mutual funds and investment advisers. It wants to give shareholders more power over corporate boards and executive compensation.
The two portions of the administration's agenda, legislative and not, are intertwined. Capital standards, for example, must be approved and implemented by banking regulators, who have expressed general approval but could differ on the details. The administration already has proposed merging two of the four agencies that oversee banks. Sen. Christopher J. Dodd (D-Conn.) would like to create a single new bank regulator.
Similarly, Congress could decide to remove from the Fed the power to implement new compensation standards.
Key Democrats continue to express confidence that the legislative issues would be resolved by the end of the year.
Geithner held a private meeting Tuesday on Capitol Hill with Dodd, chairman of the Senate Banking Committee, and Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee. Afterwards, Dodd and Frank emerged to speak with reporters while Geithner slipped away.
"I think the chances are very, very good that there will be a bill before the end of the year," Frank said.
Staff writers Brady Dennis and Zachary A. Goldfarb contributed to this report.